$KBSF: Big Potential Runner

 

-Recent management Change -Lowfloat 0.66mln shares(float less than $DCIX has) 

-Day volume is going up.

-Company operates in China market.

This is very likely the most undervalued stock you can find. We're not talking about speculative stocks that have "huge growth potential" nor likely frauds that trade at a 0.01 P/E but have been exiled to the pinksheets because they haven't filed their financials since 2011. KBSF is a stock that is:

Yahoo Finance data doesn't tell you everything and you should always refer to the SEC filings of the company to understand exactly what is going on, but it does paint a pretty clear picture as to why we think KBSF is the most undervalued stock on the market:

These stats were a snapshot when the stock was 2$. Let's ignore for a second the 1 P/E, the 0.2 Price/Sales and the fact that the company trades at just 10% of book value. Let's just focus on enterprise value because a negative amount might be misinterpreted as a bad thing.

Enterprise value is a company's market cap less its net cash (cash less debt). So a company that has a $10 million market cap but $60 million in debt has an enterprise value of $70 million. The market is pricing the company's business at $70 million because $60 million in debt would have to be paid off before shareholders see a penny of value. Conversely, a company like KBSF with $10 million in market cap but a -$15 million enterprise value means that it has $25 million cash in the bank. Investors are paying less than a dollar for a dollar's worth of cash that sits on the balance sheet for whatever reason. These types of companies represent a great deal and there is literature on the topic discussing how these types of stocks greatly outperform the market.

There is one article that is by far the best and all the other ones espousing a negative enterprise value investment strategy link back to this one as an original source. Alon Bochman, CFA wrote an article titled "Returns On Negative Enterprise Value Stocks: Money For Nothing?" that shows investing in companies with negative enterprise value resulted in an average annual return of 50.4%, and his study covered over 2,600 stocks from 1972 to 2012 so this is not a matter of small sample sizes. The one thing is he didn't not quantify how deep into negative enterprise value each company was, just that if they had negative enterprise value for one month, that stock counted in his aggregate data. One could surmise that the more deeply discounted a stock was, the better return it had, but that is just guess work. His study also showed that microcaps tended to perform the best out of this strategy and had the most opportunities. This makes sense because those are the less liquid stocks that institutions can't really take advantage of due to their small size, but are perfect for retail shareholders to skim easy profits. KBSF fits very well into this mold. Investing in stocks with negative enterprise value could be the one time that the poor little retail shareholder has an advantage over the big boys running Wall Street. So it is not a strategy to take lightly.
We believe that KBSF is one of the best opportunities out of all negative enterprise value stocks that we have seen. There are plenty of companies that trade at market caps less than their net cash, or negative enterprise value. But those are usually biotech firms after their stock price has collapsed from an ineffective drug trial or refusal from the FDA. The expectation is that they are years away from any revenue, but they have heavy cash costs right now from having to pay employees, facilities and other R&D expenses which will erode today's cash balance. Therefore, they aren't really trading below their cash balance, at least not where the market expects the cash balance to be in another few quarters.
Have a look at this stock screener, for instance. You might have to download the CSV file to get the full picture. The vast majority of them are in the healthcare sector (i.e. failed biotechs) and 19 of those 20 companies listed have negative EPS, some of them deeply negative. And the one positive EPS stock received a one-time payment from a termination of an agreement with a larger partner. Hardly a ringing endorsement of things to come
KBSF is not like any of those companies, it's profitable. Just look at the Q1 results in this SEC filing: 

As a foreign filer it takes longer than usual for the results to be filed with the SEC, so we are still waiting for Q2 results. Maybe this is part of the reason why it's so undervalued, people get bored of waiting. But the quarter ended March 2016 saw KBSF earn a 1.6 cent EPS. A 1.6 cent EPS in one quarter is a very good deal on a company with a 43 cent stock price, completely ignoring that it has negative enterprise value anyways. Revenue was flat, $9 million versus $8.9 million and the EPS is down a little bit from 2 cents to 1.6 cents, but it's not like the business is in dire straits. The revenue decline has stopped and it looks to be heading back upward with the recent online sales deal KBSF signed.

It's hard to judge based on just one quarter of financial performance, but KBSF's balance sheet has improved over the last year since it started trading at negative enterprise value (link to SEC financial filing):

balance sits at $26.7 million. This is down from $29 million from March 2015, but the company paid off substantial debts during that time with current liabilities dropping from $16.5 million to $9.3 million. Working capital, current assets less current liabilities, has improved from $53 million to $54.9 million, indicative of a company that's profitable with smart balance sheet management. With 26.5 million shares outstanding, KBSF has $2.07 per share in working capital and $1.01 per share in cash. What's funny is that even though the balance sheet is strong and improved from last year, KBSF has dropped from $6.50 to $0.40 during this time. This also throws out the theory that KBSF will always trade at a discount like some other Chinese stocks do, because at this time last year it was trading well over its book value. It can just as easily return to that state again.

The stock dropped so severely because of a bad 2014. The company's 2015 20-F filing shows that revenue dropped from $99.6 million in 2013 to $58.8 million in 2014 before recovering a bit to $61.3 million in 2015. EPS also dropped from $1 in 2013 to just a few pennies per quarter. But as we see from the Q1 2016 income statement above, revenue and earnings have stabilized. But the stock price is still at these opportunistically low levels. With the company being flush with cash, it could announce a stock repurchase plan at any time. That's why we're not too worried about the NASDAQ minimum bid price rule. With how thinly the stock trades, the company could easily push the stock over a dollar at its own will by using just a small portion of its cash balance.

The following chart summarizes the discount you are getting when you buy KBSF at 43 cents:

At 43 cents, you are paying only 42.6% of the value of the company's cash, 20.8% of its net working capital and a minuscule 11.2% of its overall book value. Not only does KBSF have negative enterprise value, it has deeply negative enterprise value we have never seen before, except for those companies kicked to the pinksheets for financial non-compliance. KBSF could double to 86 cents and it would still have negative enterprise value. It would be a 400% gainer just to come in line with its net working capital. And it goes back again to this company being profitable. It's not like this cash balance is eroding like on a biotech. It's improving.

This doesn't even consider the low earnings multiples. The enterprise value to EBITDA metric doesn't even make sense until the stock price more than doubles. And if EBITDA is $5 million going forward (Yahoo estimates trailing 12-month EBITDA at $7.5 million), an EV/EBITDA metric of 5 leads to a stock price of $2. The first dollar being just for the cash and the second dollar accounting for the $25 million in enterprise value needed to lead to a multiple of 5.

So is KBSF the most undervalued stock on the market? Our answer is yes. We challenge anyone to find a stock this deeply discounted to its cash that's profitable and in compliance with its listing. How long will KBSF remain this cheap? Well, let's refer once again to the last SEC filing on August 17:

"After the first step of cooperation with Jiangsu Spring Fountain Networks Technology Limited, we may have further cooperation in the near future and upgrade to an investment relationship. Additional details of the transaction will be disclosed if and when a definitive agreement is executed by the parties. There is no assurance that the transaction will be eventually consummated."

So the new partner is looking into investing in KBSF. Nothing is assured yet, but at prices where KBSF's cash is basically being given away for free, why wouldn't this company want to grab a piece of it?